How do we convince the EU27 that we are prepared to walk away from a bad deal?

‘No deal is better than a bad deal.” Superficially appealing rhetoric often puts politicians in a bind, and with Theresa May seemingly unable to unite her cabinet (let alone her party, let alone the country) behind any plausible deal, this slogan continues to distort the UK Brexit debate.

At one level, of course, “no deal is better than a bad deal” is trivially true – if the EU27 insisted that the price of a “deal” was that we contribute 100 billion euro a year to the EU budget, that the City of London be razed to the ground and that Manchester United be relocated to Luxembourg, few would argue for accepting it.

But that is not what we are talking about. No Deal would throw UK trade, regulation and citizens into legal limbo, with unforeseeable consequences, as we set out here. Any conceivable deal, even one that wholly or largely meets the EU’s demands, will be better than that.

And the more sensible proponents of the No deal slogan accept that; they are making a different point and once which is indeed consistent with a very simple game-theoretic model of the negotiations. This is that for the UK to maximise the benefits of any deal, it needs negotiating leverage with the EU27 – what game theorists call an outside option. And if we rule out No Deal ex ante, we have no such option. So we will be obliged to accept a terrible deal, simply because it is better than no deal at all

If, however, we convince the EU27 that if offered a terrible deal we will prefer No Deal – even if that is even worse for us – then their incentive will be to improve their offer, since while No Deal will hurt us more than them, they will still suffer. So, while No Deal would still be irrational for both sides, especially us, our negotiating position relies on having it as a possible option in some circumstances. As Sir Christopher Meyer, formerly our ambassador to the US, put it: “No deal is better than a bad deal is not just a Leaver’s slogan, but a basic principle of all competent negotiation.”

So far, the argument sounds perfectly logical.

But the problem is credibility, and it is here that things get more complicated. How do we convince the EU27 that we are prepared to walk away? Another well-known principle of game theory is that talk – even prime ministerial speeches – is cheap. Right now, no-one seriously believes that No Deal is a serious option for the UK government, economically or politically. And the progress of the negotiations so far shows that: the EU27 think the prime minister is bluffing, and sooner or later the UK will have to accept broadly the terms we are offered.

So what to do? In order to show that we’re not bluffing, we need to make the No Deal option credible. Sir Christopher recommends a two-track strategy: “The warm emollience of Florence hand-in-hand with visible and detailed preparations for no deal.”

Andrew Lilico elaborates. We should wait a few more weeks – perhaps another five or six – after setting a public deadline for the date at which we will start active preparations for a no deal scenario. It’s only reasonable and sensible to tell the EU they’re running out of time if they truly want a deal, and to give them one last chance.

As Andrew recognises, the value of this is not just or even mainly that taking action to prepare for No Deal would mitigate the costs but that actually spending time and resources on such preparations – publicly – makes it much more credible that under some circumstances we would actually be prepared to incur those costs. Once again, this is precisely what a simple game theory model would imply.

But there’s a problem, or rather several. First, preparing for No Deal, as Andrew makes very clear, is expensive : we will be spending money on things which, if the strategy is successful (that if it convinces the EU27 to make a better offer) we will not need and will be wholly or largely wasted.

More seriously, an even more important principle of game theory is that to get the best outcome, you need to take into account not just the consequences of your own actions, but how those actions will change the incentives, and hence the behaviour, of the other players. And making No Deal less costly and more credible for us changes the incentives both for the EU27 and the private sector, here and on the continent. If, as up to now, they think No Deal is not a realistic option for us, they have no reason to prepare for it. If that changes, they will.

Indeed, as fears of No Deal, whether because of deliberate strategy or incompetence on the part of UK government, have risen, that is precisely what they are doing. The Federation of German Industries has warned its members to plan for a “very hard Brexit”. In practice, that is likely to mean restructuring supply chains, arranging alternative sources of financing to UK banks, putting investments on hold or considering relocating some functions, all of which would make No Deal less painful for German firms. And it’s not just companies abroad, but business here as well, for example the UK’s large pharmaceutical sector. Even our own regulators, like the Financial Conduct Authority, are telling banks they need to plan for the worst-case, No Deal, scenario.

So the less costly and more credible we make No Deal for us, the less costly and more credible it will become for everyone else involved, business and government both here and in the EU27. Worse, it’s likely to be considerably more painful and more expensive for UK government and taxpayers than for anyone else involved. Compare the long list of things Andrew Lilico says the UK government should be doing now, from buying land near Dover to stockpiling medicines (!) to the measures German firms are likely to take.

So what’s the net effect of this? The most important impact is the most obvious. If both sides make No Deal less costly for themselves, the probability that’s where we end up is increased. That can’t be good.

Equally, however, a deal is still in both sides interests. But it’s far from obvious that our negotiating position, and hence the terms of any deal, will have been improved.

Indeed, to the extent that preparing for No Deal is easier, cheaper and quicker for the private sector and the EU27, it’s easy to imagine the reverse. Suppose – and does anyone find this implausible – by October 2018 the UK is still desperately trying to get the new HMRC computer system to be ready for an extra 240 million customs declarations, as well as to work out some stopgap arrangement to ensure planes can still fly to the continent. Meanwhile, European firms have restructured their supply chains, while their governments will, at worst, be able to blame any disruption on the UK. Who will really have the upper hand?

So “we must prepare for No Deal” may sound plausible as a way of improving our negotiating position. But in practice it makes No Deal more likely; wastes money and effort we can ill afford – and may, worst of all, if we get it wrong it may actually worsen rather than improve our negotiating position.

By Jonathan Portes, Brexit research leader at The UK in a Changing Europe and professor of economics and public policy at King’s College London. This piece originally featured in The Times.

Disclaimer: The views expressed in this analysis post are those of the authors and not necessarily those of the UK in a Changing Europe initiative.